BURSA – Fundamental Analysis (20 Jul 2015)

About BURSA

The Company is an exchange holding company, whose principal activities are treasury management and the provision of management and administrative services to its subsidiaries. BURSA operates and regulates a fully-integrated exchange, offering a range of exchange-related facilities including listing, trading, clearing, settlement and depository services. The Group offers its products covering equities, derivatives, offshore listings and services and bonds and Islamic offerings.

The four major market segments of the Group are as follows:

The securities market mainly comprises the provision and operation of the listing, trading, clearing, depository services and provision and dissemination of information relating to equity securities quoted on exchanges for the securities market.

The derivatives market mainly comprises the provision and operation of the trading, clearing, depository services and provision and dissemination of information relating to derivative products quoted on exchanges for the derivatives market.

The exchange holding business refers to the operation of the Company which functions as an investment holding company.

Others mainly comprises the provision of a Shari’ah compliant commodity trading platform, a reporting platform for bond traders and the provision of an offshore market.

Ownership

Obviously, BURSA is a government linked company because Capital Market Development Fund and Ministry of Finance are the major shareholders. They owned 43.6% of shares of BURSA.

BURSA issued ordinary shares to employees every year, and also there are potential ordinary shares which may arise from the SGP grants. Dilution of EPS is not significant

Economic Moats

Cost Advantage

Moat: Wide

BURSA is the one and only stock exchange in Malaysia. Its net profit margin throughout the years are consistently above 30%.

Switching Costs

Moat: Wide

The sole fully-integrated exchange in Malaysia.

Network Effect

Moat: Wide

The sole fully-integrated exchange in Malaysia.

It has a niche in Islamic investment products

It has the largest derivatives exchange dealing palm oil contracts.

Intangible Assets

Moat: Wide

The sole fully-integrated exchange in Malaysia.

Efficient Scale

Moat: Wide

The sole fully-integrated exchange in Malaysia.

It has a niche in Islamic investment products

It has the largest derivatives exchange dealing palm oil contracts.

The wide economic moats are further proven with high ROIC and CROIC.

Profitability

From FY11 to FY14, BURSA’s pre-tax income grew 12% in CAGR. This is mainly attributed to

In the past 10 years, BURSA has been enjoying very high pre-tax margin, and the margin increased dramatically from FY10 onwards.

BURSA has very high dependency on market sentiment. Bearish market sentiment reduces participation of trading/investing in market. This is clearly shown from FY08 to FY10.

By the way, I have adjusted FY09 pre-tax income by deducting one-time income from disposal of a subsidiary (FY09: RM75,975 mln)

The following chart shows revenue by operating revenue. Securities market is the main revenue contributor, but revenue contribution from derivatives market has been improving over the years. Evidently, we see 65% YoY (FY14: 10,514 mln; FY13: 6,371 mln) growth of revenue in Syariah compliant commodity trading platform and the reporting platform.

FY15 Q2 Results

2Q15 vs. 2Q14, QoQ

Pre-tax income 2Q15 was RM69.5 million, an increase of 5.6% from RM65.8 million in 2Q14. Operating expenses reduced –5%, but the performance was capped by flat operating revenue. Operating revenue was lethargic given weak trading revenue from the derivatives market (-5%); daily average trading volume for CPO futures fell 17%. Total segment profit for 2Q15 was RM84.2 million, an increase of 4.0 per cent from RM81.0 million in 2Q14. The movements in the segment profits are depicted in the graph below:

1H15 vs. 1H14, YoY

Pre-tax income for 1H15 was RM136.3 million, an increase of 5.9 per cent from RM128.7 million in 1H14. The 4% increase in operating revenue came on the back of higher trading revenue from the derivatives market (+20%); daily average trading volume for index and CPO futures rose 6% and 24% respectively. Total segment profit for 1H15 was RM166.4 million, an increase of 4.5 per cent from RM159.3 million in 1H14. The movements in the segment profits are depicted in the graph below:

Key Operating Drivers in the Securities Market by Quarters

The following table shows the trend of key operating drivers in the securities market by quarters.

Source: BURSA’s quarterly reports

Derivatives trading revenue improved due to higher average daily contracts (ADC) traded of 55,314 contracts compared to 46,966 in 1H2014. Of this, 81% of total trades were in crude palm oil futures and 19% in FBMKLCI futures. By participation, foreign institutions traded 56% and 33% of the FLKI and FCPO.

On the Islamic market trading activity front, the Bursa Suq Al-Sila’ (BSAS) ADV continued to show exceptional growth as:

The number of trading participants broaden to 106 (1H2014: 83)

The number of sukuk listed widened to 21 from 20 a year ago. However, market capitalization of Shari’ah compliant stocks slipped to RM1,023mn (1H2014: RM1,088mn) in tandem with weak overall market sentiments. Bursa Suq Al-ila’ (BSAS) continues to benefit from the conversion of deposits to Murabaha and the introduction of Tenor Based Pricing.

In my opinion, the market pulse and activities are still high, but I do have few minor concerns:

Liquidity

Growth rate of FCF for 5 years and 10 years is 7.8% and 8.9% respectively. This is one of the reasons BURSA can give high dividend payout.

Returns to Shareholders

The board is recommending an interim dividend of 16.5 per share. This is slightly higher than 16 sen paid in 1H2014 but note the absence of a 20 sen special dividend this year to maintain healthy capital and regulatory buffers. Nevertheless, DPS announced YTD translates to an attractive dividend payout of 91%.

The current R4Q-DY% is4.7%.

Growth Drivers

17 Jun 2014 – For the derivatives market, a new USD denominated Refined Palm Olein Futures Contract (FPOL) was launched. Bursa also inked an MoU with the Saudi Stock Exchange (Tadawul) to develop cross border activities in capital market development. A new Environmental, Social and Governance Index, to be launched in end-2014, targets Socially Responsible Investments funds estimated at USD3.4tr.

17 Jul 2014 – For the derivatives market, Bursa introduced the new participantship structure for trading and associate participants – to increase the number of licensed traders and expand the distribution channel.

17 Jul 2014 – More ETFs (exchange traded funds) – a form of passive investment fund that offers investors benefits of diversification – are also in the works including for equities, commodities and indices for other stock exchanges. In 1Q14, the MyETF MSCI Malaysia Islamic Dividend was introduced.

21 Oct 2014 – Higher revenue is expected from the Islamic market unit, where Bursa Suq Al-Sila’ (BSAS) recorded higher utilization of its commodity trading platform by both local and foreign participants.

The Islamic capital market continues to register positive growth. The need for Shariah compliant products is expected to increase further due to the demand from Islamic funds as well as those funds dedicated to ethical investments. Wider usage of Murabahah contracts is expected to spur greater utilisation of our commodity trading platform, Bursa Suq Al-Sila’ (BSAS).

Issues/Risks/Challenges

8 May 2015 – The number of public listed companies on the local bourse has been on a downward trend. From 957 companies in 2010, it shrank to 906 last year.

Similarly, the number of new listings have decreased — there were 29 new listings in 2010 compared with 28 in 2011, 17 in 2012, 18 in 2013 and 14 in 2014.

In contrast, the total funds raised rose to RM24.3 billion in 2014 from RM22.5 billion in 2013. A total of RM32 billion was raised in 2012 compared with RM15 billion in 2011 and RM33 billion in 2010.

Bursa is not the only stock exchange that is seeing a slowdown in IPO exercises this year. As at end-March, Singapore only had one IPO listing. Meanwhile, the Stock Exchange of Thailand saw five listings in the first quarter of this year while the Indonesia Stock Exchange had two.

The participation of retail investors in Bursa remains weak. In 2013, despite the strong post-election rally across the board, the opening of CDS accounts fell to its lowest in seven years. This could mean the rally failed to attract new investors, particularly the younger ones. Between 2009 and 2013, the number of CDS accounts only grew from 4 million to 4.4 million.

However, retail investors’ trading interest is not the only the factor that can lift market velocity

At Wall Street, retail participation is minimal in the US, but there is a big pool of hedge funds that help churn trading volume.

Deferment of key IPOs in 2015 – The slowdown in initial public offering (IPO) activity raises concerns about the vibrancy of the local bourse, which may affect Bursa’s earnings and, in turn, its dividend payments.

Debt crisis at Greece, meltdown of China’s stock market as well as lingering domestic issues should continue to cast a long shadow over market sentiment. Hence, the current choppy market environment is likely to stay, driving investors to the sideline or to exit. Overall, lackluster trading activities is expected in the securities market over the short-term.

5-Y DCF

Bad Scenario (4.0% – 6.0%): From 7.56 to 8.37 (Uncertainty Risk: HIGH to VERY HIGH)

Ugly Scenario (0.0% – 2.0%): From 6.18 to 6.83 (Uncertainty Risk: VERY HIGH to EXTREME)

At current price (8.1), based on RDCF, assumption of FCFF growth rate in the next 10 years is 5%.

Softer trading activities is expected in the near term as sentiments remain depressed by broad macro uncertainties and concerns over potential outflow in foreign funds in the 2H. On the other hand, I think BURSA still has room to grow in long term, and it is protected by expected excess of 90% dividend payout. I believe that BURSA fair value worth from 10.3 to 11.40.

Going Forward

This financial year will remain challenging in view of expected softer trading activities in the near term as sentiments remain depressed by broad macro uncertainties (debt crisis at Greece, meltdown of China’s stock market as well as lingering domestic issues) and concerns over potential outflow in foreign funds in the 2H.

BURSA’s attractive dividend will the main catalyst for the stock.

I will continue to hold and accumulate BURSA as I believe that BURSA has the ability to overcome the challenges ahead.